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American Pilots

“American and British pilots were forced to learn about this lethal athlete the hard way.”

-Ian Toll


Don’t blame the pilots. Blame the politicians. They were willfully blind to obvious risks and put our bravest in the sky anyway. That’s one of the key risk management and leadership lessons I learned from Ian Toll’s excellent new book about WWII, Pacific Crucible.


“The Mitsubishi A6M Zero was a dog-fighting champion, and aerial acrobat that out-turned, out-climbed, and out-maneuvered any fighter plane the Allies could send against it… The Zero had been placed in service in the summer of 1940, almost 18 months before Pearl Harbor… it was yet another example of the fatal hubris of the West in the face of plentiful evidence..” (pages 52-53)


I read about war because it educates me on winning and losing. Every decision counts. Decision processes matter. There has been “plentiful evidence” that the US Dollar has been driving The Correlation Risk in Global Macro markets since 2007-2008. There has also been an outright obfuscation of facts by Western Academics who have chosen to ignore it. It’s un-objective and un-American.


Back to the Global Macro Grind


The US Dollar is up for the 7thconsecutive day and US Stock Futures are indicated down for the 7thconsecutive day. There is absolutely zero irony in this causal relationship. Policy expectations drive currency prices.


In the absence of immediate-term expectations for an iQe4 upgrade of Gold and Oil price inflation from Ben Bernanke, the US Dollar has arrested its decline – and stocks and commodities have arrested their ascent.


Here’s a real-time update on the surreal Correlation Risk (inverse correlations between the USD and asset prices) developing:

  1. SP500 = -0.90
  2. Euro Stoxx = -0.92
  3. CRB Commodities Index = -0.94
  4. WTIC Oil = -0.89
  5. Gold = -0.89
  6. US Equity Volatility (VIX) = +0.93

Yes, you’ll notice that in the Romper Room that has become Keynesian Economic Policy outcomes, one of these things is not like the other – one of these things just doesn’t belong. It’s called volatility.


The US Federal Reserve has a 2-stroke mandate:

  1. Price “stability”
  2. Full Employment

We have neither. We have price volatility like the world has never seen. And we have forced American Pilots of other people’s hard earned moneys to chase their own tails of performance going after short-term and short-sighted Policies To Inflate.


As US Dollar Debauchery has only proven to Slow Global Economic Growth via accelerating short-term food and energy price inflations, now world markets have to deal with the other short-term side of the trade:

  1. Growth Slowing (until it slows at a slower rate)
  2. Deflating The Inflation (Bernanke’s Bubbles in Oil, Gold, etc. are popping)

When these 2 things are happening at the same time, you just cannot ignore the capital losses. They happen real fast.


That said, what’s been fascinating about this -4.6% draw-down in the SP500 from its April 2nd, 2012 top (capital loss from the Russell2000 March 26th, 2012 top = -6.9%) isn’t the absolute performance impact, but the Storytelling.


The Most Read (Bloomberg) headline this morning epitomizes the storytelling of the Old Wall: “Dow Falls For 6th Day In Longest Losing Streak Since August On Greece.


On Greece? C’mon. Americans in this profession are better than that.


You can look at real-time market signals (leading indicators) in 2-ways at this stage of the Fed Fight:

  1. What’s happened on the margin (draw-downs) from the YTD tops in February-April
  2. What’s happened YTD

The YTD thing is all about the Storytelling. Just don’t do it with my money. Last I checked, the SP500 is still down -13.5% from its willfully blind 2007 high and needs to be up almost +16% (from here) just to get The People and their 301ks back to break-even.


Everything that happens on the margin in markets matters most to the American and Global Macro Pilots who are trying to manage your money’s real-time risks. What happens on the margin is what drives fear and greed. It’s also what builds or destroys confidence.


If you don’t have planes or markets that the pilots can trust, you’re one step closer to losing whatever is left of the money they are willing to flow back to the politicized decision making process that’s driving markets.


Bottoms are processes, not points. We humbly suggest you fly these risky skies of Federal Reserve sponsored Price Volatility with the credible analytical sources out there who have actually landed the planes for the last 5 years.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, and the SP500 are now $1, $110.23-113.89, $79.42-80.28, $1.29-1.31, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


American Pilots - Chart of the Day


American Pilots - Virtual Portfolio


A slight beat from our estimate and we were above the Street



  • In March, first junket licenses were issued. They believe that it will help them in the intermediate term. They are confident that there will be more licenses issued over the next 12-18 months. First IMA's started operating in May. 
  • Raised funds that will enable them to pursue new projects; their location remains disadvantaged

  • Issued largest bond offering in S'pore in March
  • EBITDA margin: 48%
  • Gained market share in mass - due to better promotional spending
  • 1Q VIP hold rate: 3.4%
  • Remain committed to growing the company with new projects


  • No comment on location of their new project other that they will likely announce something in the next 12-18 months.  Not interested in Europe.  JV/direct investment are both possible.  If they went into Japan, they would go in with a partner. 

  • Balance of 2012 capex for West Zone: S$500MM; Not all the capex in the quarter is related to West Zone - there is a timing differential in paying contractors for past work already completed.  They will likely not pay all the 500 in 2012 though. 
  • Total S'pore capex so far (ex. WC, land): S$5.5BN
  • Cannot allocate tables to the IMAs   
  • They are only at the beginning of hiring IMAs. There will be very minimal revenue impact from the IMAs over the next few months. The very tight regulatory process allows them to go through with the government of what is allowed and what is not allowed.  It's a very structured learning.  So if and when the IRA allows other junkets to come in, they will know how to best utilize them- especially if the rules get modified.

  • RC volume share: 49%; mass drop: 47%
  • Rolling win mix on a net revenue basis was 36%
  • Mass hold %: 22.8% 
  • Net revenue share: not comparable since they deduct more costs 
  • No change on the VIP commissions; they continue to be very cautious on giving credit.  Do not want to overextend themselves.  They give a higher rebate to customers to get an early payment.
  • RC volume growth QoQ was +29%
  • Mass floor revenue QoQ: +8%; slot growth was higher relative to tables
  • 2,440 slots in end of 1Q; 702 ETGs
  • No changes on government regulations on advertising.  What the government did is simply clarify what was ok or now.

  • Still a few pending IMAs that have not been rejected
  • Hotel occupancies are not constant since they have to reserve rooms for the VIP; not concerned about the decline in occu and margins QoQ. Added 200 more rooms in 1Q. Hotel margins: 60%
  • Margins on USS and everything else is where there is upside
  • Rentals should be finished (West Zone) in 4Q 2012; costs will ramp up in the next few quarters but margins for 2013 will be better
  • Next few quarters will be focused on USS; once break-even point passed (6,000-7000 visitors), there is $0.80 per $ flowthrough to bottom line
  • 1Q Table count: 562 tables (MASS/VIP%: 1/3, 2/3); in terms of capacity, "they are almost there."
  • 1Q: 8,400 average visitors in USS; attendance went up 14% YoY
  • 1Q pre-opening: $2MM 
  • The significance of the IMA contribution depends on which ones get approved.  At most, IMA can contribute 30-40%. 
  • VIP hold rate may stabilize around 3.0-3.1% but that's just a guess
  • IMA don't collect debt at this point but they guarantee it

  • Continue to be cautious on extension of credit for rest of year



  • Group revenue of S$787MM and S$EBITDA $376.4MM 
  • Non-gaming revenue up 16% YoY
  • USS grew its daily average visitations by 14% to 8,400 visitors at an average spending of about S$88. Hotel business improved as occupancy rate increased from 79% to 86% with an average room rate of S$338. However, overall revenue for first quarter of 2012 was affected by lower win percentage and business volume in the premium player business when compared to first quarter of 2011. 
  • On quarter to quarter basis, overall casino gross revenue grew by 9% as a result of higher business volume in all gaming business segments.
  • Consequently, the Group’s net profit for the first quarter of 2012 was S$211.5 million as affected by the revenue mentioned above and higher depreciation with the opening of new attractions in USS, the Maritime Experiential Museum, Equarius Hotel and Beach Villas compared to first quarter of 2011. This was mitigated by lower finance costs in first quarter of 2012 as a result of lower effective interest rates and lower loan principals.
  • On 12 March 2012, the Company issued S$1,800 million 5.125% perpetual capital securities at an issue price of 100 per cent. The perpetual capital securities were issued for the Company’s general corporate purposes as well as to finance capital expenditure and expansion of its business.
  • The Group spent a total of S$262.4 million for construction work-in-progress and other property, plant and equipment during the financial period.

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JP Morgan Suffers 'Significant' Mark-to-Market Losses

CRI: Short It


Nearly all the factors that kept this stock grinding higher while estimates came down last year are either slowing, or flat-out reversing, on the margin. We really like the 3/1 odds on the short side.

We think Carter’s is shaping up as a short again. After nearly a year of perceived positive factors at its back, we think that opacity related to organic earnings power will be gone, and competitive challenges will emerge at a time when it is shifting away from harvesting its prior investments, and will need to put capital in to its model that will put a ceiling on margin improvement at a minimum, and likely create meaningful downside if our industry call for increased competition and margin pressure comes to fruition. With that, sales deceleration is a near certainty barring another acquisition, and valuation is sitting near the seven-year peak.

We say ‘shaping up as a short again’ with full awareness that it did not do what we thought it should have done in 2011. In fact, we went into 2011 with estimates for the year at $1.75 and the consensus at $2.40. By year’s end, the Street came down, and down and down by 21%, and CRI earned an adjusted $1.94 (before $0.15 Bonnie Togs accretion). Yet the stock literally defied gravity and went the exact opposite direction – gaining 35% for the year (vs. virtually flat performance for S&P, RTH and the MVRX).


If there’s one rule of retail investing that we’ve learned over time, it’s that earnings revision is the key factor in determining the direction of a stock. Pull up the <EEG> function on your bloomberg. With 9 stocks out of 10, you’re going to see that the stock price tracks (or leads) earnings in a very tight band.  Take a look at NKE, AAPL, GIL earnings revisions vs. the stock (all courtesy of Bloomberg).




CRI: Short It - nke




CRI: Short It - aapl



CRI: Short It - gil


Now look at CRI. HUH?


CRI: Short It - cri 


Whenever we talked to people about this name, we were given the same bull factors ad nauseam:

1)  The company had the toughest COGS comps in 2H11, in advance of which it took up prices by 10%. In doing the math, a 10% increase on a $10 product at retail almost entirely outweighs a 25% increase in a $3-4 product cost.

2)  At the same time, CRI was boosting its off-price sales from 1% of total in 2010 to 4% in 2011, and while this would ordinarily be dilutive to margins, it was enough to help leverage SG&A.

3)  While both of these two factors played out, CRI benefitted from the addition of the Bonnie Togs acquisition, which boosted sales by an average of 6% per quarter – again, a factor that (with some minor cuts to acquired SG&A) helped leverage SG&A at the greatest rate in nearly a decade.

4)  And how could we forget the ultimate response?  “The market is flat, I’m clawing to hang on to my return/loss for the year, and you expect me to short the stock of a company that Berkshire Partners is not-so-slowly taking private?


Now what have we got?

1)  The good news is that CRI starts to anniversary its higher product costs (that’s the bull case), but unfortunately, it starts to anniversary its pricing initiatives as well. It’s all too often that people adjust one without the other. There are, after all, two components to gross margin. Costs are forecastable. But prices to consumers – especially for a company where 40% of sales come from vertically-owned-retail – are DEFINITELY not.

2)  Off price sales should come down from 4% of sales last year, to about 2% this year. Yes, that’s good for gross margin. But on top of other factors impacting top line, it will make any form of SG&A leverage very difficult.

3)  Bonnie Togs is still there. But it is officially anniversaried. Now it and Carter’s each need to grow on their own without the benefit of basic acquisition accounting helping the situation.

4)  Expectations are lofty – at or above company guidance for sales and EPS.

    • Revenue: Consensus at $2,370mm – ABOVE guidance of $2,300mm – $2,342mm.  
    • EPS: 2012 Consensus at $2.61 – ABOVE guidance of $2.51-$2.61                                        
      • Consensus EPS of $3.28 for 2013, and $3.63 for 2014. We’re at $2.70 and $3.00, respectively.                                                 
      • With all these other factors no longer in CRI’s favor, we have a tough time stomaching the premise that the <EEG> chart on bloomberg maintains its scant correlation under these circumstances with a 20% earnings reduction.                                                           
      • If our estimates prove right, there’s no reason this stock can’t see the low-mid $30s. But under the most bullish consensus expectations, we still have a tough time getting this name in the upper $50s. We like the 3/1 odds of a short here.

 5)  And lastly…the “Berkshire is Buying” argument is pretty much dead in the water. Yes, they’re selling on the margin.



Historical context is important here...


We were asked a couple of weeks ago by a top client as to why CRI traded at such a high EV/Sales ratio (2.1x) circa 2005. Our answer sounded something like this:


This was when CRI achieved cult stock status. There were several factors, all related to post IPO action.


The pitch on the IPO was…

a)  Shift away from basics into playwear

b)  Shift from traditional dept store biz to serving 1) mass channels, and 2) company-owned retail.

c)  CRI had new arrangements with Li&Fung – through which it cut its sourcing costs by nearly 1/3 and passed right through to consumers in the form of lower prices to gain share.

d)  Remember that this period (ending April 2007 when LIZ went Ka-Boom) was easy for apparel retail. You could be an average brand and run at peak margins without much effort. The environment allowed CRI to sell into three completely distinct channels with like product without stepping on each other’s toes – and the Street was not only oblivious, but it also gave CRI’s multiple credit for this as a big positive.

e)  Then in 2005 CRI bought Osh Kosh. In the ensuing 2-years, they cut employee count from 400 to less than 100. Margins went up temporarily, before growth slowed and the story became outwardly and visibly broken.

f)  Pretty soon thereafter, people realized that this name was not infallible – that it can’t sell the same stuff through Target, Kohl’s, Macy’s and its own stores -- and that it can’t cut costs to keep margins high in the face of slowing growth.
g)  Fred Rowan (CEO) got fired in 2008, and since then, the Mike Casey era has taken hold. Definitely a better regime. But there was just as much financial engineering as anything else (he was former CFO). CRI had to button up policies due to a markdown irregularity accounting issue w KSS, as well as an exec being charged with fraud and insider trading by SEC in 2010. Nonetheless, it’s got a long way to go before it’s worthy of ‘cult stock’ status again. Our point is that today it is sitting at 1.25x EV/Sales. That’s well below the prior peak of 2.1x, but the old peak is just that…the OLD peak. It need not apply any more.

Playwear has nearly doubled as a percent of CRI’s total over the past ten years. ‘Baby’ is a very defendable business – the Carter’s brand goes a long way with a new Mom swaddling her newborn. But in the Playwear category, it competes with everything from Children’s place, to Old Navy, to JC Penney and Wal-Mart private label. Not a place to hang your hat on.


CRI: Short It - CRI Categories




Just listening to the Arcos Dorados call last week, it was clear that Brazil was the topic du jour.  The country was referenced 36 times during the 1Q11 conference call versus 13 times in the 1Q10 earnings call.   We think that two key risks exist for ARCO (with repercussions for MCD); in the near term, management may need to bring its same-restaurant sales guidance lower while in the longer term, we believe that unit growth may be overly aggressive.  In that case, margins and returns will deteriorate.


Brazil is a very meaningful market for Arcos Dorados, representing 67% of the company’s EBITDA and 35% of its total units.  Same-store sales are running at 1% in April versus 9.2% in posted for 1Q.  As the chart below indicates, the top-line trend does not look positive for Arcos Dorados.


WHAT’S WRONG WITH MCD BRAZI? - arco brazil comps



So what is it that ails McDonald’s in Brazil?  Management pointed out that “we experienced a noticeable slowdown at the end of 2011 which continued into the month of January.”  The company attributed this to “a temporary low in Brazilian consumer spending, which picked up in February and is expected to accelerate through the remaining quarters.”  What’s confusing to us is that government data detailing consumer spending during the same quarter showed a significant acceleration in 1Q. 


Not only did consumer spending rise, but the services sector expanding in April also.  Moshe Silver, our Portuguese-speaking Chief Compliance Officer and Managing Director, recently informed us that Brazil’s services sector PMI advanced to 54.4 in April, up from 53.8 in March, seasonally adjusted.  This compares to the industrial sector PMI, which declined from 51.1 in March to 49.3 in April, even as the government implemented stimulus programs.


With all of this in mind, taking into account what other consumer companies are seeing, McDonald’s recent fortunes in Brazil are all-the-more perplexing.  Lapping last year’s highly successful Big Mac promotion of last year is a big difficulty for Arcos Dorados but this slow down seems to be reflective of more than tough comps.  On a year-over-year basis, the company is emphasizing its “value platform” much more, which has been a tried-and-tested strategy of McDonald’s when trends slow.  With same-store sales trending at 1%, traffic does not seem to be booming for ARCO.   Current guidance is still calling for high-single digit comps this year; this seems like a stretch to us.


Below we have provided a selection of quotes from consumer-facing businesses in Brazil.  The commentary from each of these companies does not rhyme with the weakness that ARCO is highlighting.  The corollary from this is that the pain McDonald’s is feeling in Brazil could be self-inflicted.  It is difficult to prove, but the first factor that springs to mind as a possible driver of this is the overbuilding of stores.  As the chart below illustrates, Arcos Dorados have been aggressively growing its unit count over the past three years.  The boom in building came at a time when the Brazilian economy was very strong and, if there is now an oversupply of McDonald’s restaurants, it could be a problem for ARCO’s return on its investment.  If an oversupply of units is not behind the slowdown in McDonald’s business in Brazil at the moment then it likely will be if the trajectory of new unit openings continues with comps in low-single digit territory. 


While this is a difficult thesis to prove, we think it is likely that slowing new unit growth could be a tactic pursued by management if comps fail to pick up next quarter.


WHAT’S WRONG WITH MCD BRAZI? - arco brazil units





As the commentary, below, states, consumer-facing companies in Brazil did not highlight any macro weakness as a reason for softness in business trends.  The only factor that was offered by way of an excuse was the unseasonably wet weather in January. 


Starbucks: I think we're quite encouraged with what's going on in the Americas on a macro level in markets like Brazil. And in Latin America, markets continue to perform well with strong comp growth and a long runway for additional stores. In fact, our comp growth in Brazil is outpacing our expectations, which is evidence that our stores and brand continues to be well-received.


Starwood Hotels & Resorts Worldwide, Inc.: Latin America continues to be our fastest-growing region with RevPAR up 14% in Q1. Brazil and Chile were both up over 20% with double-digit rate growth. Business and leisure travelers are returning to Mexico where RevPAR grew 17%. Occupancies at our resorts were up almost 1,000 basis points. U.S. groups are once again looking at Mexico as an attractive destination. Argentina lags and we are monitoring the situation closely. At this point, all indications are that Latin America will remain our fastest growing region.


Fidelity National Information Services, Inc.: Brazil was very strong. We're continuing to see nice growth in both not only accounts but also transactions. We're also seeing nice growth in our EBITDA margins.


Marriott International, Inc.: Over the last 12 months, international arrivals to our hotels in the U.S. increased 7%, arrivals from Brazil were up 16%, and arrivals from China were up 32%.


Kraft Foods, Inc.: Developing markets posted a double-digit increase, led by strong growth in Latin America. Brazil was up nearly 30%, driven by strong Easter shipments and leveraging marketing campaigns supporting (03:55) 100th anniversary.


Avon Products, Inc.: Our largest market, Brazil, was us 2% in constant dollars, driven by 6% growth in Beauty, which was partially offset by double-digit decline in Fashion & Home. In Brazil, our new general manager and his team have been focused on understanding the drivers of recent performance and identifying the required steps to win competitively while delivering profitable growth.


Stoneridge, Inc.: Brazil's GNP growth has declined to an annualized rate of 2.8%, which is starting to impact the Brazilian consumer market. PST distributors and retailers are experiencing less demand for aftermarket products as the overall economy softens and they are making adjustments to their inventory positions to reflect the current market demand.


Anheuser-Busch InBev SA: Turning now to Brazil, despite, cooler and rainier weather than normal in January and helped by positive impacts from the increase in minimum wage, industry volumes grew by 3% in the quarter. We outperformed the market with our beer volumes growing by 4%; results in a market share of 69% for the quarter which represents a gain of 70 basis points versus the same period last year.


Procter & Gamble Co.: A few highlights include India delivering a 39th consecutive quarter of double-digit sales growth, Brazil growing sales over 30% and building share for the 25th consecutive period and Russia growing value share for the tenth month in a row.


Coca-Cola FEMSA SAB de CV: Our South America division delivered solid top line results in the first quarter of 2012, despite bad weather conditions in Brazil and Columbia.


Owens-Illinois, Inc.: Overall, Brazil has gone through a little bit of a coaster ride over the last couple of months. The government is clearly opening the faucet at this point in time to drive economic activity again. And certainly in the projections that we're getting from our customer base, that's clearly reflected for the latter part of the year.


PepsiCo, Inc.: Emerging markets revenue growth was particularly strong, up 13% on a constant currency basis, led by strong double digit organic revenue growth of 21% in India, 13% in Brazil, 33% in Saudi Arabia, and 26% in Egypt just to name a few.


Whirlpool Corp.: As we discussed on the last call, the Brazilian government declared an appliance sales tax holiday in December. The program originally set to expire on March 31 was extended for an additional 90 days through June 30, 2012 as expected. Irrespective, however, of the stimulus program, we continue to be very positive about the prospects for our Brazil and Latin American international business.



Howard Penney

Managing Director


Rory Green


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